Non Convertible Debentures (NCD) Issued by NBFC: A Complete Overview

Deepti Shikha

06 Jan, 2021

Non-convertible Debentures or NCDs are a popular method of raising funds for the NBFCs. The majority of borrowers in the NCD market are from the NBFC segment. Muthoot Finance, Indiabulls Housing Finance, M&M Financial Services, Edelweiss Housing Finance, Diwan Housing Finance and SREI Infrastructure Finance are some of the well-known names raising funds through non-convertible debentures (NCDs).

The Reserve Bank of India (RBI) has tightened the guidelines for non-convertible debentures (NCDs) issued by NBFC. Many savvy investors choose to lock their funds in the non-convertible debentures issued by NBFC. In NCDs, the investors can lock their funds for a longer period of time at a profitable rate of interest.

What is NCD or Non-Convertible Debentures and Why is it Called Non-Convertible?

• Non-Convertible Debentures or NCDs are the financial instruments used by companies to raise long-term capital. The companies perform this action through public issue of shares. NCDs are a debt instrument.
• NCDs are a debt instrument having a fixed tenure, and people who make an investment in these receive regular interest at a certain rate.
• There are some debentures that can be converted into shares after a certain point of time. This is usually done at the discretion of the owner. However, this is not possible in case of non-convertible debentures; this is the reason they are known as non-convertible debentures or NCDs.
• Non-Convertible Debenture (NCD)  also means a debt instrument issued by a corporate including the NBFCs with original or initial maturity up to one year and issued by way of the private placement.

How is NBFC dependent on NCDs?

Non-Banking Financial Companies or NBFCs raise money by way of issuance of capital or debt securities, including debentures through public issue or private placement. Hence, a substantial increase in borrowings of NBFCs has been witnessed through the issue of debentures major being on private placement basis.

What are the Benefits for Investors in the Non-Convertible Debentures (NCD) Issued by NBFC?

The major benefits for investors in the Non-convertible debentures (NCD) issued by NBFC are:

Higher Interest Rates

Non Convertible Debentures (NCD) issued by NBFCs usually pays interest at the rate of 150-175 basis points much higher than what banks pay on their Fixed Deposits. Since many of the NBFCs issuing these NCDs are reputed as well as, well-capitalized, there is not much risk in for investors in investing in them. Apart from these, the fact that the NCDs issued by NBFC are closely regulated by the Reserve Bank of India (RBI) is a positive feature for the investors. The interest rates keep on fluctuating on other investments, hence in these circumstances, the NCDs offers a good instrument to lock the returns for a longer period of time.

Capital Appreciation on NCDs

Apart from locking at higher rates, there is another advantage in making investments in NCDs issued by NBFC.  In case the rates depreciate from 25-50 basis points from the current levels, then the investor enjoys capital appreciation on the NCDs, which is apparent in their market price.

Secured Investment

The debentures normally have got first charge or second charge on the assets of the issuer. Hence they are secured and typically safe as compared to other forms of investment. This provides an added advantage along with the higher rates of return and the prospects of capital appreciation.

What are the Risks Associated with Non –Convertible Debentures Issued by NBFC?

Investors must be cautious regarding the risks associated with the NCDs issued by NBFC before committing funds to them. Some of the risks are enumerated below:

• There are a diverse class of assets in NBFCs. NBFCs are divided into two levels that are high-quality NBFC and low-quality NBFC. Investors must use their discretion and invest in NCDs issued by NBFC only after checking the credit rating of these NCDs. The Credit rating is an expert opinion on the repayment capacity of the issuer, and it is advised to stock to high rated NBFCs only.
• The NBFC sector is vulnerable to regulation. In the year 1998, when the RBI had imposed heavy regulations on NBFCs in terms of capital adequacy and requirements as well as asset clarification, many of the NBFCs operating at that point of time became bankrupt. The macro and regulatory risks still exist for the NBFC sector.

What are the Features of NCDs issued by NBFC?

The Features of NCDs issued by NBFC have been explained below:

Taxation

The tax implications of the investor on the Non-Convertible Debentures (NCDs) issued by NBFC depends on the tax bracket of the investor. In case if the NCDs are sold within a year or less than a year, the STCG will be applicable as per the income tax slab rate of the investor. In case, the NCDs are sold after one year, or before the date of its maturity, LTCG will be applicable at the rate of 20% with indexation.

Credit rating

The credit rating agencies such as CARE, CRISIL etc. rank the NBFCs. The basic purpose of this rating is to determine the potential of a company. If a company gets a higher credit rating, then it means that the company has the ability to fulfil the credit obligations. However, a low credit rating would mean that higher risks are involved in the company. In case any issuing company does not make payments, then the rating agencies give them lesser ranking.

Interest

The Non- convertible debentures (NCDs) issued by NBFC offer a high-interest rate. The interest rate usually ranges from 8% to 12%. The interest payouts are calculated either monthly, quarterly, half-yearly or annually.  Cumulative payout option is also offered by NCDs.

Who Can Issue NCDs?

Any corporate or NBFCs are eligible to issue NCDs if it fulfils the criteria mentioned below:

• The NBFCs or corporate is having a tangible net worth of not less than Rs.4 crore according to the latest audited balance sheet.
• The company has been endorsed a working capital limit or term loan by banks or all India financial institution.
• The classification of the borrower account of the company is done as Standard Asset by the financing banks or institution.

What is the Procedure for Issuance of NCDs in NBFCs?

The process for issuing NCDs has been mentioned below:

• The financial positions of the company must be disclosed to the prospective investors as per the standard market practice.
• The investors must get a certified copy of investors specifying that the company has complied with all the eligibility criteria stipulated by the RBI.
• The requirements of all the provisions of the Companies Act, 2013 or regulations set up by RBI shall be complied with by the company.
• The debenture certificate must be issued within the prescribed period specified in the Companies Act, 2013.
• The NCDs issued at face value carrying a coupon rate or a discount rate to face value as zero-coupon instruments is determined by the corporate.

Provisions of Law Applicable to Private Placement of Debentures or NCDs Issued by NBFCs

Companies Act, 2013 and Rules (Company’s Act)

Section 42 – Offer or invitation for subscription of securities on private placement and

Rule 14 of Companies (Prospectus and Allotment of Securities) Rules, 2014 dealing with Private Placement

According to Section 42 of the Act read along with Rule 14 provides for:

• Private placement of the securities through the issue of the offer letter,
• The number of persons to whom securities are to be issued,
• The manner is prescribed for collection of money payable toward subscription of securities.
• The minimum investment size limit for subscription is specified.
• The maximum time period is specified for allotment of security.
• The maintenance and filing of records and offer letter with the Registrar and with SEBI, in case of a listed company, and
• Filing of return of allotment with Registrar.

However, the Revised Guidelines have categorized the issue of the private placement of NCDs in two categories

• Category A: A limit of 200 subscribers during a financial year
• Category B: No limit on the number of subscribers.

Under the revised guidelines, minimum investment aligned with Companies Act, 2013 to be Rs. 20,000.

Section 71 of the Companies Act, 2013 and Rule 18 of Companies (Share Capital and Debentures) Rules, 2014 deals with Debentures

Section 71 of Companies Act, 2013 read with Rule 18 specifies the provision for the tenure of secured debentures,

• Its nature of security that must be created,
• The amount of Debenture redemption reserve  (DRR) that must be maintained,
• Procedures relating to the appointment, eligibility and duties of debenture trustee and meeting of debenture holders etc.

As per Section 71(4), every company issuing debentures must create a debenture redemption reserve (“DRR”) account from the profits of the company which is available for payment of dividend. The amount that is credited to such account shall be utilized only for the purpose of redemption of such debentures.

Note: However, according to Rule 18(7) (b) (ii) of Companies (Share Capital and Debentures) Rules, 2014, no DRR needs to be maintained for privately placed debentures by NBFCs.

Section 77 of the Act, 2013 requires registration of charges.

Section 77 of the Act, 2013 provides that every company creating a charge on its property /assets /any of its undertakings, whether tangible or otherwise, must register the particulars of the charge with the Registrar within thirty days the creation of the property.

For Category A -it is compulsory for non-convertible debenture to be fully secured in favour of subscribers.

For Category B -The issuer has the option to create security in favour of its subscribers.

As per the terms of NBFCs (Acceptance of Public Deposit) Directions, 1998-the debentures must be secured by mortgage of immovable property /any other asset of the issuer company. Creation of security by way of mortgage of immovable property will require registration under this section.

SEBI Regulations

SEBI (Issue and Listing of Debt Securities) Regulations, 2008

The regulations of SEBI here apply to:

(a)The public issue of debt securities.

(b) The listing of debt securities issued through public issue or on private placement basis on a recognized stock exchange.

Hence, these regulations will not be applicable to privately placed debentures unless the issuer is to get the listing of such debentures.

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009

These regulations regulate the issue of convertible debentures on a preferential basis by listed NBFCs.

RBI Directions

The Revised Guidelines

From February 20, 2015, onwards, NCDs issued by NBFCs any – whether it is public or private/ listed or unlisted, on a privately placed basis, are governed by the revised Guidelines and provisions of the same.

Directions Issued by Reserve Bank on Non-Convertible Debentures

The Directions issued here will be applicable to Non-Convertible Debenture (NCD) by including NBFCs with original or initial maturity up to one year and issued by way of the private placement.

RBI through its notification on February 20, 2015, issued the guidelines on Private Placement of NCDs having a maturity of more than 1 year by the NBFCs.

It is not applicable to tax-exempt bonds offered by NBFC.

The NBFCs formulate a Board approved policy for resource planning/ covering the planning perspective and periodicity of the private placement.

RBI has specified the guidelines majorly for issuance of a private placement of NCDs of 2 categories:

• Category A- With a maximum subscription of less than Rs. 1 crore.
• Category B- With a minimum subscription of Rs. 1 crore and above.

Conclusion

Organizations rely on raising funds using NCDs only to meet a specific business purpose. They must provide clarity on the matter where and how the money will get invested. Investments made across various firms can reduce the risk considerably. NCDs in NBFC provide a better rate of interest so it can be profitable in the long run to make an investment there. The perfect time for the selling of the NCDs is when the interest is due. It is the prime trading for non-convertible debentures. You can make a good amount of money from there.